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Supplementary Paper Series for the "Assessment" (3) Inflation-Overshooting Commitment: An Analysis Using a Macroeconomic Model

July 13, 2021
Takuji Kawamoto*1
Jouchi Nakajima*2
Tomoaki Mikami*3


In its "Inflation-Overshooting Commitment," the Bank of Japan commits to continuing to expand the monetary base until the year-on-year rate of increase in the CPI exceeds the price stability target of 2 percent and stays above the target in a stable manner. Through the commitment, the Bank of Japan is implementing a so-called "makeup strategy," which aims to offset a part of past inflation misses from the target by allowing actual inflation to overshoot the target for some time and thereby stabilizing average inflation over the business cycle. Existing studies have shown that such makeup strategies are actually effective for the U.S. economy. This paper examines the effectiveness of the makeup strategy for Japan's economy, where inflation expectations formation is known to be largely adaptive. Specifically, we build a small-scale macroeconomic model for Japan's economy and conduct simulation analysis to study the implications of adopting the makeup strategy for early achievement of the inflation target as well as the incurring social welfare costs. Simulation results show that when the inflation rate has been below the target, it is effective to stabilize average inflation by offsetting the past inflation misses over some makeup windows. In addition, the results suggest that when the natural rate of interest is lower, the optimal makeup window becomes longer.

JEL classification
C53, E31, E47, E52, E58.

Monetary policy, Inflation-overshooting commitment, Makeup strategy, Average inflation targeting, Stochastic simulation.

This paper is a supplement to "Assessment for Further Effective and Sustainable Monetary Easing" released by the Bank of Japan in March 2021.
The authors thank the staff at the Bank of Japan for their valuable comments. The authors are also grateful to Tatsushi Okuda, Tomiyuki Kitamura for valuable comments in an early stage of the analysis.

  1. *1Research and Statistics Department, Bank of Japan
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  2. *2Research and Statistics Department, Bank of Japan
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  3. *3Research and Statistics Department, Bank of Japan
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